Summary Treasury - Risk and Hedging Notes

TREASURY AND HEDGING NOTES
Centralized vs Decentralized
 Centralized – treasury acts as the ‘bank’ of the group, ensuring that each department
has access to the correct funds at the correct times
 Decentralized – each subsidiary/department within the group – manages their own
funds

Advantages of being Centralized
 Avoid mix of surpluses/deficits – in subsidiaries/departments bank accounts
 Larger amounts of money – can be invested
 Borrowing – can be done in bulk
 Expertise of EEs – ability to specialize
 Buffer cash – is lower
 Better control – due to standardized procedures and risk management

Advantages of being Decentralized
 Sources of finance – can be diversified and paired with local assets
 Greater freedom and responsibility – given to subsidiaries and departments
 The local treasury function – can respond better/quicker to local operating units

Treasury as a Cost or Profit Centre
Cost Centre
- Aim – keep costs as low as possible and keep costs within budgeted targets
- Perform a service – to other departments

Profit Centre
- Aim – to generate a profit for the co
- Usually through – speculative transactions

Advantages & Disadvantages of a Profit Centre
Advantages Disadvantages
- Staff motivated – to obtain best possible - If treasury speculates with futures – can
return for the co lead to huge losses
- If treasury asks a fee – subsidiaries would - If treasury asks a fee – subsidiaries might
be more aware of costs and use treasury use 3rd parties instead of internal
department diligently department
- Difficult to measure and judge performance
- Admin costs – can increase

DERIVATIVES – IFRS 9

, A financial instrument or other contract – with ALL:
 Its value changes – in response to the change in a specified interest rate, FI price,
commodity price, foreign exchange rate or other variable
 Requires no/small initial investment – compared to other types of contracts with
similar reaction
 Settled on – a future date
 Examples – option, forward contracts or futures contracts

Primary Derivative Instruments
1. Option – Right, but not obligation, to buy/sell at a specified price on a future date
2. Forward Contract – Commitment to buy/sell on a specified date at a specified price –
not standardized
3. Futures – Commitment to buy/sell on a specified date at a specified price – standardized

1. OPTIONS


Option Terminology
 Seller/Writer – party that sells the option
 Buyer/Holder – party that buys the option
 Premium – price paid by the buyer to the seller of the option
 Strike/exercise price – contract price at which the holder CAN buy/sell the asset
 Call option – right to buy an asset at a set price (exercise price)
 Put Option – right to sell asset at a set price (exercise price)
 Option premium – usually a percentage of the spot price

How are Options Created
 Co acquire options – to hedge against volatility of e.g. commodity prices and exchange
rates
 Issue options to investors – as source of finance
 Share options to employees – in form of share based payments – mostly to senior
management
 Options on large listed companies – are created by independent parties e.g. investment
banks
- These are called warrants – and are listed on the JSE.
 Can be traded on the JSE Derivatives Market or Over the counter (OTC)




Value of Options